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Citigroup and the 'Straw That Broke the Camel's Back'

NEW YORK (TheStreet) -- It appears Citigroup (C - Get Report) was the victim of some very bad timing, with the discovery of a large fraud within its Banamex unit in Mexico in February.

While the regulator didn't say as much, it appears the Banamex fraud factored heavily in the Federal Reserve's decision to reject Citigroup's 2014 capital plan. The regulator late Wednesday announced the results of its annual Comprehensive Capital Analysis and Review (CCAR), which is the second part of the regulator's annual stress-test process.

The first round of stress tests -- called the Dodd-Frank Act Stress Tests (DFAST) -- was completed on March 20, with 29 of the 30 banks showing they could remain well-capitalized with Tier 1 common equity ratios of at least 5.0% through a nine-quarter "severely adverse" economic scenario. Zions Bancorporation (ZION) of Salt Lake City failed the test.

Neither Citigroup nor Wall Street analysts had expected the bank's capital plan to be rejected. After all, Citi passed the first round of stress tests showing a strong minimum Tier 1 common equity ratio of 7.2% through the Fed's nine-quarter "severely adverse" economic scenario. That was the second-highest ratio among the "big six" U.S. banks, with only Wells Fargo (WFC) showing a higher first-round minimum Tier 1 common equity ratio, at 8.2%.

Goldman Sachs (GS) passed DFAST with a minimum Tier 1 common equity ratio of 6.9%, while JPMorgan Chase (JPM) showed a minimum Tier 1 common equity ratio of 6.3% in the first round, Morgan Stanley (MS) had a minimum ratio of 6.1%, and Bank of America (BAC - Get Report) came in lowest for any bank passing the first round of stress tests, with a minimum Tier 1 common equity ratio of 5.9%.

Aside from Citigroup, all of the big-six banks had their capital plans reviewed, as detailed here.

The Federal Reserve said it had rejected Citigroup's capital plan on "qualitative" factors, and not because of the bank's capital level.

"While Citigroup has made considerable progress in improving its general risk-management and control practices over the past several years, its 2014 capital plan reflected a number of deficiencies in its capital planning practices, including in some areas that had been previously identified by supervisors as requiring attention, but for which there was not sufficient improvement," the regulator said.

Citigroup CEO Michael Corbat in a statement late Wednesday said, "Needless to say, we are deeply disappointed by the Fed's decision regarding the additional capital actions we requested. The additional capital actions represented a modest level of capital return and still allowed Citi to exceed the required threshold on a quantitative basis."

Citi had requested the Fed's approval to raise its quarterly dividend on common shares to a nickel from a penny, and to repurchase up to $6.4 billion in common shares from the second quarter of 2014 through the first quarter of 2015.

Downgrade

KBW analyst Fred Cannon on Thursday downgraded Citigroup to a "market perform" rating from an "outperform" rating and lowered his price target for the shares to $52 from $58, while calling the Fed's rejection of the bank's capital plan the "Straw That Broke the Camel's Back."

"It is now obvious to us that capital return to investors will not occur as soon as we expected," Cannon wrote, adding that the discounted market valuation for Citi's stock compared to peers is "warranted based on the lack of capital return which will likely impair C's ability to meet stated return targets, increased risk associated with a global consumer footprint following the Mexico fraud losses, and expected downward pressure on consensus estimates."

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